The euro on the ballot paper?

What impact will the looming elections in Europe have on the euro and the markets?

Revolts against the political establishments of advanced countries are becoming commonplace. The Brexit and Trump decisions have so far been positive for shares in the UK and US, despite big doubts and unhappiness for many in markets on the news.

Investors soon decided Mr Trump’s planned economic policy is designed to provide a substantial stimulus. His negatives on trade policy are thought to be more than offset by the tax cuts and extra spending he would like to put through. Meanwhile, the economic news in the UK remained positive after the vote, allowing markets to rise after an initial large mark down. The Italian referendum turned out to be discounted by the time the answer was published. We need to ask how much further can this trend go – and what might it do to markets next year?

The first contentious election is likely to be in mid-March in the Netherlands. The country is governed by a fashionable grand coalition of the centre left (PvdA) and centre right (VVD) main parties, the equivalents of Labour and Conservatives. They won 79 seats between them in a 150 seat Parliament last time, with the Conservatives narrowly ahead with 41 seats able to choose the Prime Minister.

Next year will be a challenging time for traditional European parties and for the EU and euro scheme they are defending.

The latest opinion polls make grim reading for both the governing parties. They show the VVD down to 24/25 seats against 41, and the PvdA down substantially to 7-12 seats compared with 38. The main winner in all this is the Freedom party, PVV, of Geert Wilders. PVV are now on 31-35 seats compared to 15 last time, and would be the largest minority party in the Parliament. This party pursues a strident campaign against Islam and migrants which offends liberal views of tolerance and human rights. The party recommends leaving the EU. Economically the party is against the euro, believing the Netherlands will be better off with its own currency, the guilder. The party wants a mixture of tax cuts and controls on state benefits and subsidies.

It is unlikely the PVV will leapfrog into government. In the polls they are well off the pace of winning an outright majority, and will find many other parties reluctant to form a coalition with them. It is possible their popularity will wane before the election takes place. It is possible the polls are wrong and are overstating them, though so far pollsters have usually understated the strength of the challenger and populist parties in favour of the established ones. If the PVV emerges as the largest minority party in a very split Parliament, as the polls imply, they will doubtless have influence over the direction of whatever precarious coalition does form. Whilst it is unlikely they can do well enough to turn Dutch policy to withdrawal from the euro, their important presence in the election will ensure the euro is on trial.

In France there is a similar position. Most people expect a final run-off for the Presidency between the centre right candidate, François Fillon, and the National Front (NF) candidate, Marine Le Pen. The French NF have toned down their anti-migrant language, but retain their opposition to the euro and much of the EU scheme. Polls show an easy win for Mr Fillon, but once again the euro and the EU scheme will be an important part of the debate. Polls may be underestimating the support for Mme Le Pen. The campaign may shift Mr Fillon more in the Le Pen direction, as he works to ensure he wins.

Next year will be a challenging time for traditional European parties and for the EU and euro scheme they are defending. It looks as if the euro will survive its electoral tests, but it is not helpful to its development that it has become so contentious a teenager. Its midwives expected it by now to be grown up and accepted.

Various challenger parties are blaming the euro for high unemployment and stagnant wages, and questioning the policy of freedom of movement which goes with the currency. We should expect some market lurches in response to these volatile events. It will be interesting to see what, if any, adjustments the EU makes as it witnesses these serious debates about its future in a series of national elections, where many voters will want change.

It is less likely the challenger parties on the continent will win control, as Mr Trump did in the USA, given the fragmented voting patterns and the proportional systems used to decide the results in many cases. We have seen that a challenger party can win, as Syriza did in Greece. In that case the new government was unable to change euro-area policy, despite trying to do so. The noise and fury of the elections may however, trouble markets from time to time.

The above article by John Redwood, Charles Stanley’s Chief Global Economist, was first published by Charles Stanley on 9th December 2016.

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